“I can’t stress enough: Boards are now being asked to look at things in great detail,” said Kathleen Moriarty, Partner at Katten Muchin Rosenman LLP. “We spend a lot of time educating the Board,” she said, referring to the Board of Directors of alternative mutual funds. It’s simply that the Board is required to understand the fund at a deeper level than ever before.

She described a recent instance of going over the legislation on mutual funds, called the 40 Act, or more formally the Investment Company Act, with a client. “I was citing all the sections that protected the investor and he piped up, ‘where is the section that protects the manager?’” She had to explain the 40 Act was devised after individuals were still feeling heat from the Great Depression. “The 40 Act is very protective, even now,” she said.

The number of restrictions and limitations is quite daunting, Moriarty said. The act covers on liquidity, leverage, derivatives and complex assets, valuation. “For example, for dividend or non-dividend funds, you must disclose when greater than 25 percent of the fund occurs in a particular industry sector.” The Internal Revenue Service (IRS) has rules for a regulated investment company (RIC) that are not even part of the 40 Act.

As well, “there are lots of back office things,” said Moriarty. Depending on what happens with the portfolio, marketing and advertising materials must be constantly updated. “Keep an eye on the custody requirements,” she advised. Sometimes an exchange-traded fund (ETF) would get added to the mutual fund, and the manager would treat it as simple equity, not as an instrument issued by an investment company.

Another example is the “names rule.” If, for example, a mutual fund is named “small cap” then at least 80 percent of the portfolio must be designated as small cap. When small cap companies grow, this can mean a major change to the fund constituents.

Moriarty said that managing liquid alternative mutual funds versus managing hedge funds is a real “clash of cultures.” She estimated it would be more difficult for a hedge fund person to move into alternative mutual funds. This is because the rules are so complex in the latter. “It’s really hard to keep all the rules in mind at the same time.” This makes alternative mutual funds feel “completely different from the hedge fund world.” ª